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Treasuries And Corporate Debt, Two Different Stories

Written by A Forex View From Afar on Tuesday, December 16, 2008

Even though lately, yields on the instruments the U.S. government uses to borrow, treasury notes, have fallen to zero, or close to it, the yields for corporate debt is trading at a record high.

For example, the long term debt paper issued by Verizon, which has an investment grade rating, yields around 9%, while, debt issued by Kodak Eastman yields a whopping 17% for a 5 year maturity period. At the same time, treasuries are trading at records lows and some investors are even accepting negative yields (theoretically the borrower should receive interest from the lender). The equivalent treasury yield for the Verizon loan is around 2.60%, 3 times less, while for Kodak’s debt is 1.50%, 11 times less.

This is pretty much a consequence of a very low liquidity environment and safety flights, not to mention the herd mentality. Investors are selling every possible asset, in order to buy treasury notes, lifting their price. Because of the reverse relationship between the price of a bond and its yield, when investors buy a bond, its yield drops.

Expensive debt means two important things. First, it adds additional expenses since the company would have to pay much more for their debt. Second, it threatens some companies with bankruptcy, because they cannot access liquidity for the daily operations or raise enough cash to water the credit crunch’s consequences.

This is not a healthy environment for business’ to prosper, and it spells trouble ahead. So tomorrow, even thought the Fed had cut 75 basis points, the only real winners are the treasury notes, and not the real economy.

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